Bitcoin Update: Alerts and Guidance Issued by the SEC, FINRA and IRS

It’s Buyer Beware, according to guidance and alerts issued recently by the SEC, FINRA and IRS concerning risks inherent in Bitcoin. Bitcoin is described by all three offices as a decentralized, peer-to-peer virtual currency that can be used in place of, and traded for, traditional currencies, though is not backed by any central authority, government bank or otherwise.

First, the IRS released Notice 2014-21 on March 25, 2014 in question and answer format to describe the tax implications of Bitcoin. Generally speaking, the IRS has taken the stance that Bitcoin will be considered property, and for investors, may constitute a capital asset, requiring reporting of gain or loss based on fair market value. Given the opaque nature of Bitcoin, this may cause further risks to investing, as investors may be required, by themselves, to calculate gains and losses, a job typically taken up by banks, wire houses and clearing firms.

The SEC, in its second Bitcoin alert dated May 7, 2014, reiterated risks associated with investments in the digital medium. Given that Bitcoin is a relatively new innovation, the SEC warned that it has a potential to give rise to frauds that may propose “guaranteed” high rates of return.

The SEC alert listed several warning signs of potentially fraudulent conduct, in addition to promises or “guarantees” on return:
• Unsolicited offers, including cold-calls or emails;
• Unlicensed sellers, or individuals or businesses that are not registered with FINRA, the SEC or other regulators;
• No net worth or income requirements;
• Any offer that sounds too good to be true (these sorts of investments often are); and • Pressure to buy immediately.

The SEC alert also highlighted the very large volatility in the valuation of Bitcoin, noting that the exchange rate has dropped more than 50% in a single day. Given this extreme volatility, even reputable businesses may inappropriately attempt to solicit investment via Bitcoin. The SEC noted that in March 2014, the Texas State Securities Board issued an emergency order against an oil and gas company for soliciting investments via Bitcoin for exploratory wells in West Texas. While oil well exploration is well-known to be a risky endeavor, the emergency order was made because the solicitations were deemed unregistered securities, and if the business held Bitcoin, it could affect the amount of money available for business operations, a risk not disclosed in its solicitations.

The FINRA investor alert noted other risks, including that due to the international and anonymous nature of Bitcoin, investments are not guaranteed, are irreversible, and may be implicated in illegal activities. If an investment is made that turns out to be fraudulent, it may be hard or impossible to recover your losses, as the investment/currency is not backed by any U.S. banks or federal regulatory agencies.

Investments based on bitcoin must still be marketed and sold in accordance with securities laws and related regulations, and so must be suitable for investors appropriate under each specific investor’s circumstances. If you believe you were not properly informed of the risks associated with an investment involving bitcoin, please contact the attorneys at Malecki Law to determine if you have a claim for damages.